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Provisional Measures Concerning Retention Money for Construction Works in China

On January 12, 2005, the PRC Ministry of Construction ("MOC") and the Ministry of Finance Issued the Provisional Administrative Measures for Retention Money in connection with Construction Works (the "Retention Regulations") (Jlan Zhl [2005] No. 7) for the purpose of regulating the administration of retention money and to ensure the observance of repair liabilities during defect liability periods. The Retention Regulations came Into effect on the date they were issued and contain Important points that need to be considered when drafting construction contracts for works in China.

The Retention Regulations define retention money as "an amount of money withheld, as specified in the contract for construction works between employer and contractor, from construction payments to ensure repair by contractor within the defect liability period of any defect in the construction works." Defects are similarly defined to mean "situations and instances where the works quality deviates from or fails to comply with mandatory standards. design documents or the provisions of the construction contract." The defects liability period (often called warranty period) is defined as six months, 12 months, or 24 months, as specified by the employer and contractor in the construction contract.

Article 3 of the Retention Regulations requires the employer to specify in the tender documents all details relating to the withholding and return of retention money. Specifically. the employer must Include contract provisions dealing with:

• The method for withholding and the return of retention money;
• The percentage amount of retention money and the duration;
• Whether the retention money Is interest bearing. and If It Is, the method for calculating the Interest;
• Duration of the defects liability period and the method of its calculation;
• Dispute resolution procedures with regard to withholding of retention money, its return, quality of repair. and repair costs;
• Claims for defects during the defects liability period.

For government-financed works, Article 4 provides that the retention money shall be managed. throughout the defects liability period, In accordance with regulations regarding centralized payment from the state treasury. For privately financed works, the employer and the contractor may set up an escrow arrangement with a financial institution for the withheld retention money. Interestingly, Article 4 also provides that where other methods of quality guarantee, such as quality warranty or quality insurance, are used, the employer is not permitted to withhold any retention money.

In relation to the commencement of the defects liability period, Article 5 provides that it will commence from the date of completion acceptance or the date of delivery of the project by the contractor for acceptance by the owner. Where delay is caused by the contractor, the defects liability period will commence from the actual date of the completion acceptance or the actual date of delivery for acceptance. Similarly, where delay is caused by the employer, the defects liability period will automatically commence 90 days after delivery by the contractor of the completion acceptance report or delivery for acceptance.

For state-financed construction works, 5 percent of the contract price will be withheld as retention. For privately financed construction works, Article 7 provides that the amount of retention should have reference to the provisions of the Retention Regulations. In other words, it would appear that 5 percent retention is anticipated for private construction works as well, and it may be difficult to justify withholding more from contractors.

Article 8 provides that during the defects liability period, the contractor will be responsible for, and bear the cost of, repairing defects caused by the contractor. Where the contractor fails to make the repairs or pay the costs of such repairs, the employer may deduct the cost of the repairs from the retention money. Such repairs or payment will not release the contractor from its general Indemnification obligations. For defects caused by others, the employer Is required to arrange for the repair of such defects at no cost to the contractor, and the employer is not permitted to deduct such repair costs from the retention money.

Articles 9 and 10 govern the return of the retention money and provide that upon the expiry of the defects liability period, the contractor must apply to the employer for return of the retention money, provided that the contractor has strictly and diligently observed its contractual obligations during the defects liability period. The employer is required, within 14 days of receipt of such application, to verify the contractor's application in accordance with the contract provisions. The retention money will be returned to the contractor within 14 days of completion of such verification if everything is found to be in order. Interest will accrue on any late payments at the interest rate of bank loans for the same term, and the employer will be held liable for breach of its obligations in the case of any late payment. Any failure by the employer to respond within 14 days of the contractor's application for return of the retention money shall be deemed to be an agreement by the employer to return the retention money, if such failure is not remedied within 14 days of a further request from the contractor.

The Retention Regulations should be welcomed as they provide another means of security for owners and developers undertaking construction works in China. What is perhaps unclear is whether the Retention Regulations permit owners to withhold retention in addition to requiring performance guarantees. Arguably Article 4 prevents this, but Article 4 is more concerned with quality rather than performance as a whole, and therefore it is certainly arguable that it would not prevent an owner from requesting performance guarantees as well as retention. Another issue is whether retention above 5 percent for private projects will be valid. Commonly, retention of 10 percent is used for international construction projects, and it will be interesting to see whether the MOC will seek to enforce the 5 percent cap on projects in China.